Policy paper

VAT: tackling aggressive abuse of the Flat Rate Scheme

Published 5 December 2016

Who is likely to be affected

Any users or prospective users of the Flat Rate Scheme (FRS).

General description of the measure

The measure will introduce a new 16.5% FRS rate for businesses with limited costs, such as many labour only businesses. This will prevent abuse and make the FRS fairer. This will reduce the incentive for firms and agencies to move employees to self-employment to exploit VAT simplification aimed at small businesses.

Businesses using the FRS, and new businesses joining the FRS, will complete a simple test, using information they already hold, to work out whether they must use the new 16.5% rate. To support businesses we will introduce an online tool that will enable both current and prospective users of the FRS to determine whether they must use the new rate.

Draft secondary legislation will be published on 5 December 2016 and businesses will have 8 weeks to comment. During this time we will engage with representative bodies to explore the practical implementation of the test and the online calculator.

Policy objective

VAT rules require businesses to offset the VAT on costs against VAT on sales to produce a net VAT payable to HM Revenue and Customs (HMRC). To save small businesses from having to doing this, the FRS sets flat rates for trade sectors as a proxy for the amount of net VAT for a normal business in that sector.

However, where the self-employed, labour only businesses or other businesses with limited costs - register for VAT and use the FRS, this results in a large cash advantage. This is because they use the flat rate appropriate to their trade sector but have significantly lower costs than most small businesses in that sector.

The new 16.5% flat rate will remove the cash advantage for those businesses with limited costs.

These changes will create a more level playing field for all small businesses, while keeping VAT accounting simple for the small businesses that use the FRS.

Background to the measure

The FRS was introduced in 2002 to simplify VAT for small businesses.

Detailed proposal

Operative date

The measure will have effect on and after 1 April 2017.

Current law

Section 26B of the VAT Act 1994 gives HMRC the power to make provisions that allow eligible businesses to calculate their VAT due as a percentage of their turnover. The regulations can be found in SI 1995/2518, Regulation 55 (as amended). Details of the current FRS provisions can be found in VAT Notice 733. This also contains the new anti forestalling provisions, which have the force of law.

Proposed revisions

Currently businesses determine which flat rate percentage to use by reference to their trade sector. This measure introduces a new 16.5% rate for all ‘limited costs’ businesses where costs of goods are either: less than 2% of turnover; or greater than 2% of turnover but less than £1,000 per annum. Goods are specifically defined for the purposes of the measure.

When the measure is introduced, businesses using the FRS or considering joining the FRS will need to consider whether they are a ‘limited costs’ business. For some businesses this will be obvious; others will need to complete a simple test to determine whether they must use the new 16.5% rate. Businesses using the FRS will be expected to ensure that, for each accounting period, they use the appropriate flat rate percentage.

Anti-forestalling legislation was published on 23 November 2016 in a revision to Public Notice 733 and should be read alongside this measure.

Summary of impacts

Exchequer impact (£m)

2016 to 2017	2017 to 2018	2018 to 2019	2019 to 2020	2020 to 2021	2021 to 2022
-	+195	+130	+130	+125	+115

These figures are set out in Table 2.1 of Autumn Statement 2016 and have been certified by the Office for Budget Responsibility. More details can be found in the policy costings document published alongside Autumn Statement 2016.

Economic impact

This measure is not expected to have any significant macroeconomic impacts.

Behavioural effects have been included in the costing to account for expected trader responses including switching from the FRS to standard VAT accounting, deregistering for VAT and other possible mitigation.

Impact on individuals, households and families

This measure will only affect individuals that are VAT registered and only to the negligible extent set out in the business impacts section below. The measure has no impact on other individuals, households and families. Neither is it expected to impact on family formation, stability or breakdown.

Equalities impacts

It is not anticipated that there will be adverse impacts on any group sharing protected characteristics.

Impact on business including civil society organisations

This measure is expected to have a negligible one-off impact on FRS businesses that will need to familiarise themselves with the new rules, but there will be an on-going cost of applying the new test. Estimates of compliance costs are shown in the tables below.

To support businesses we will introduce an online tool that will enable both current and prospective users of the FRS to determine whether they must use the new 16.5% rate.

Businesses using the new rate will pay more tax than previously if they continue to use the FRS. We estimate that approximately 4,000 businesses may decide to switch to standard VAT accounting, as this could mean they pay less VAT. If businesses make this decision, the compliance cost of switching to standard VAT accounting may be about £180 per business. Alternatively, some businesses may choose to de-register from VAT. Almost two thirds of the FRS population consists of businesses under the compulsory VAT registration threshold and if their financial gain from the FRS is greatly reduced then many of them may decide to de-register. If businesses make this decision, their administrative burdens may reduce by about £390 per business on average.

For some businesses, it will be very clear whether the value of goods they purchase is above the test threshold. However, many will be close to the threshold and will need to complete the test to determine whether they are a limited costs business. These businesses will incur an administrative burden of about £65 per business. It is likely that a large proportion of FRS users are employing an accountant or a tax advisor who would carry out the test as part of their service. The administrative burden will only increase for a small proportion of FRS businesses whose costs are close to the test threshold, do not employ an accountant and do not wish to de-register. This is estimated to be around 24,000 businesses.

Estimated one-off impact on administrative burden (£m)

One-off impact	£m
Costs	negligible
Savings	-

Estimated ongoing impact on administrative burden (£m)

Ongoing average annual impact	£m
Costs	1.5
Savings	-
Net impact on annual administrative burden	+1.5

HMRC will be engaging with representative bodies, to discuss practical aspects of the implementation of the test and the online calculator and further understand the impacts on businesses.

There is no impact on civil society organisations.

Operational impact (£m) (HMRC or other)

HMRC will incur one-off capital costs estimated at £415,000 plus £4,000 service cost per annum for a 5-year period. This will be used to provide an online calculator and to update the online VAT registration service.

All costs are estimated at a high level, based on the limited requirements available and subject to change.

Other impacts

Other impacts have been considered and none has been identified.

Monitoring and evaluation

This measure will be kept under review through information collected on VAT returns and communication with affected taxpayer groups.

Further advice

If you have any questions about this change, please contact Alison Evans on email: itpt.vatregistration&accountingpolicy@hmrc.gsi.gov.uk.